Chicago's Fiscal Freefall: Moody's Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It's All Junk Now - InvestingChannel

Chicago’s Fiscal Freefall: Moody’s Cuts Chicago Credit Rating to Two Steps Above Junk; Snake Oil and Swaps; It’s All Junk Now

Last week I wrote an article for the Illinois Policy Institute on the hugely unfunded and deteriorating nature of numerous Illinois’ pension systems.

I will post the article on Monday. 

My article was on on state pension systems, not Chicago’s, and was written well ahead of downgrades of Chicago’s debt by Moody’s on Friday. I was not surprised to see the downgrade.

Let’s take a look at some articles on the debt downgrade starting with Chicago Credit Rating Cut by Moody’s to Two Steps Above Junk.

Chicago had its credit rating cut to within two steps of junk by Moody’s Investors Service because of mounting pension liabilities, underscoring the city’s fiscal stress as Mayor Rahm Emanuel faces an unprecedented runoff.

The one-step reduction to Baa2 affects $8.3 billion of general-obligation bonds, which were already the lowest-rated among the 90 biggest U.S. cities, excluding Detroit. The outlook remains negative, signaling more cuts are possible, New York-based Moody’s said Friday in a report.

“The city’s credit quality could weaken as unfunded pension liabilities grow and exert increased pressure on the city’s operating budget,” Moody’s analysts Matthew Butler and Rachel Cortez wrote. “We expect substantial growth in unfunded pension liabilities even if the city’s recent pension reforms survive an ongoing legal challenge.”

The third-most-populous U.S. city has $20 billion in unfunded pension obligations that it can’t address without the approval of the state legislature. State lawmakers in June restructured two city pension plans with about $9.4 billion in underfunded liabilities for about 60,000 municipal workers and retirees by making them pay more and reducing benefits. The changes didn’t apply to the police and fire systems.

Labor unions in Chicago sued to block the law in December, and the litigation was put on hold pending the outcome of an Illinois Supreme Court ruling on a state pension overhaul.

Chicago May Owe Wall Street $58 Million After Moody’s Rating Cut

To add insult to injury, Chicago May Owe Wall Street $58 Million After Moody’s Rating Cut

Chicago may have to pay $58 million to unwind interest-rate swaps after Moody’s Investors Service cut the city’s credit rating within two steps of junk because of mounting pension liabilities.

The reduction on Friday to Baa2 affects $8.3 billion of general-obligation bonds, which were already the lowest-rated among the 90 biggest U.S. cities, excluding Detroit. The outlook remains negative, signaling more cuts are possible, underscoring the city’s fiscal stress as Mayor Rahm Emanuel faces a runoff election.

Because of stipulations in four of the city’s swaps contracts, which it entered into as a hedge, the rating cut may terminate the agreements early and trigger the $58 million cost, Moody’s said in a report. The city is also closer to ratings that may force an additional $133 million of payments.

“This is a very significant, negative development for the city of Chicago’s financial position,” Laurence Msall, president of the Civic Federation, a nonpartisan research group in Chicago, said in an interview. “This is a very big deal.”

Swaps agreements, which issuers enter into with banks, exchange fixed interest payments for floating ones. They’re designed to cut borrowing costs. They can backfire when interest rates move in an unexpected direction, as happened in the U.S. with the Federal Reserve keeping its overnight target close to zero since 2008. Most swaps can be ended if one party fails to maintain a minimum credit rating, requiring payment of the entire amount due.

Chicago has 15 agreements tied to variable-rate general-obligation debt and one to variable-rate sales-tax bonds, according to Moody’s. While the company said the city has the resources to cover the $58 million payment, it said the cut moves Chicago closer to further termination payments triggered by going below Baa2 or Baa3.

Chicago, like Illinois, has struggled with rising pension costs. The city is obligated to pay $600 million into four pension funds in next year’s budget, though Standard & Poor’s said the contribution may be delayed after Feb. 24 elections led to a runoff vote between Emanuel and Jesus “Chuy” Garcia.


Fiscal Freefall

Reuters has still more gloomy details in its report Chicago Nears Fiscal Free Fall with Latest Downgrade.

Chicago’s finances are already sagging under an unfunded pension liability Moody’s has pegged at $32 billion and that is equal to eight times the city’s operating revenue. The city has a $300 million structural deficit in its $3.53 billion operating budget and is required by an Illinois law to boost the 2016 contribution to its police and fire pension funds by $550 million.

Cost-saving reforms for the city’s other two pension funds, which face insolvency in a matter of years, are being challenged in court by labor unions and retirees.

State funding due Chicago would drop by $210 million between July 1 and the end of 2016 under a plan proposed by Illinois Governor Bruce Rauner.

Moody’s said Chicago’s rating could be cut if Illinois courts find pension reform laws enacted to shore up the state’s financially ailing pension system and for two of Chicago’s retirement systems are unconstitutional. A ruling by the Illinois Supreme Court on one of the laws could come as early as this spring.

S&P warned of a multi-notch downgrade if the city fails to come up with a sustainable plan this year to pay its escalating pension contributions.

In a report, Moody’s noted that the downgrade to Baa2 moves the city closer to termination of 11 more swaps deals. Termination on those contracts would potentially cost Chicago an additional $133 million, Moody’s noted.

Snake Oil and Swaps

When a snake oil salesman at the country fair says his potion will cure you of whatever ails you, you can rest assured the following three things will happen if you try some.

  1. It will taste terrible.
  2. It will not work.
  3. You will wish you didn’t buy it.

Similarly, when Wall Street peddles swaps, the following things are highly likely, if not virtually guaranteed.

  1. The contracts will be extremely one-sided with many loopholes for the Street and none for the city.
  2. The swaps will cost the city that enters them lots of money, and the termination fees will be excessive.
  3. Cities will wish they never entered into the agreement.

Musical Tribute

As music fans might have expected, I have musical tribute to honor the city of Chicago and the state of Illinois. Although I like “My Kind of Town”, I have a more appropriate offering in mind.

Link if video does not play: Paper Lace – The Night Chicago Died (Live)

Blue Ribbon Awarded

Illinois gets the blue ribbon for being the lowest-rated state. However, credit raters differ on Chicago.

  • Moody’s rates Chicago at Baa2, two steps above junk.
  • S&P grades the city A+, the fifth-highest rank and four levels above Moody’s. 
  • Fitch Rates Chicago two steps higher than Moody’s. 

The S&P and Fitch have it wrong. Both will eventually catch up.

And if the pension crisis is not fixed (it won’t be), Chicago and numerous other Illinois cities will all be junk rated.

In retrospect, I offer this thought “It’s All Junk Now!“. All that remains is for the credit rating agencies to catch on.

Mike “Mish” Shedlock
http://globaleconomicanalysis.blogspot.com

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